March 10, 2022

The market has spent the past six weeks etching a volatile, tedious bottom, with numerous secondary measures offering encouragement, the biggest of which is an ongoing positive divergence in the number of stocks hitting new lows, which tells us fewer stocks are participating in the downside. That’s good to see, but what we really need to see now is real, sustained buying pressure--so far, that hasn’t been the case, so we’re remaining generally defensive.

Market Overview & Model Portfolio Update

Setup is There—but No Buyers Yet
As we wrote a few weeks ago (and have written about dozens of times during the past couple of decades), most people will have you believe that the market bottoms all at once, but in reality, bottoms are normally a process that plays out for a while under the surface. As with most things in the market, bottoms generally take time, as big investors reposition their portfolios and stocks build new launching pads.

And that’s exactly what we’ve seen occur during the past six weeks. Since hitting a nadir in late January, the major indexes have tested those lows twice and (so far) have held. And while prices haven’t fallen much during that stretch (the Nasdaq is a bit below the prior low), investor sentiment has certainly gotten more bearish, spurred on by horrible news overseas, and yet fewer stocks are participating in the downmove. The chart here shows that: As the Nasdaq has dipped late last month and earlier this week, the number of stocks hitting new 52-week lows has dried up from a peak of 1,755 January to 803 this week—something that’s often seen near market low points.

Granted, it’s not a perfect picture—given the damage among growth stocks, there are still very few names that are showing legitimate setups (that will take even more time). But the point is that the broad market has put in some time to etch a low, with some other measures (worsening sentiment, a selloff in defensive stocks) also going into the plus column.

The missing (and most important) ingredient? Buyers! While we’ve seen some evidence that the sellers are running out of ammo, there aren’t many signs that the buyers are stepping up—bounces have tended to last just a couple of days before sputtering out, news-driven moves remain the norm and any non-commodity stock that runs into (or leaps above above) resistance has quickly come right back down. Bigger picture, our intermediate-term (Cabot and Growth Tides) and longer-term (Cabot Trend Lines) trend models remain clearly negative.

On the plus side, there should be some opportunities in certain commodity names should they shake out and rest a bit more (we talk more about commodity stocks later in this issue), and our massive cash position could have us nibbling on a resilient stock or two even without a true market upturn. But our overall point is that the market has put in the time to form what could be a solid setup; however, until the buyers really step up, it’s best to remain mostly patient and avoid the market’s meat grinder.

What to Do Now
We’re as ready and as anxious as anyone for the next rally, but we can’t force it to happen, so with our primary trend following indicators negative and few stocks moving up yet, we advise a continued defensive posture. This week, we took partial profits in Devon Energy (DVN), leaving us with 76% in cash. We could put a bit of that back to work if the bottoming process continues, but any major buying will wait for a real market upturn.

Model Portfolio Update
The Model Portfolio has been basically twiddling its thumbs since late January, holding a ton of cash and, ideally, waiting for a solid bottoming process to play out. Happily, there’s more evidence that’s what has been happening of late, with the positive divergence in the number of new lows on the Nasdaq (since January) and the NYSE (since the invasion began). Of course, stopping going down is one thing—we still need to see more up action to get some green lights, but it’s certainly encouraging.

That said, we actually raised more cash this week, though it wasn’t because of the overall market; commodity-related names have been counter-trending from the general market of late, leaving many extended to the upside and a bit obvious given the news of the day (invasion, inflation, etc.). Thus, we booked partial profits in Devon Energy, leaving us with a cash position of 76%. (See below for much more on our reasoning for the partial sale.)

Even so, our main focus right now is on ferreting out potential fresh leaders of any sustained advance that develops. Some of those could be on shakeout-type buys in the commodity space— some look to be relatively early in their runs, so shakeout/pullback buys are possible, though fresh growth leaders are really what we’re hunting for.

As for a game plan: If either (or both) of our Cabot or Growth Tides turn bullish, we’ll likely put something like 20% of the portfolio back to work—enough to boost exposure, but not a cannonball-into-the-pool due to the bearish Cabot Trend Lines and lack of legitimate growth stock setups. Really, though, let’s see how it goes in the days ahead; the bottom-building process has gone according to plan, so the action from here should tell us a lot about whether the market is finally ready to head higher for a while.

Current Recommendations

Arista Networks (ANET)—When we look back on the reasons for buying and then holding ANET in recent months, we saw a relatively early-stage stock (big coming out party occurred just in November of last year) that was being driven by the first signs of a multi-year upcycle in demand for its high-speed networking wares, especially from giant cloud operators—which in turn would lead not just to accelerating growth but also to a lot of surety, too, given the massive orders the big boys were placing. And, really, we think all of that has held up pretty well: While we’ll never say a 25%-plus correction is pleasant, Arista has held up well given the growth stock destruction, and its two recent tests of the 40-week line have found support. But similar to the overall market, we see the stock as approaching a key point—if ANET can hold up around here and pick up steam should the market rally, it would go a long way toward confirming that the stock should be among the leaders of the next upmove, but a decisive dip under the recent lows would more or less lump the stock in with so many of the other names that have cracked. Having held through the downturn and bottom-building process so far, we’re happy to give shares a chance; while it’s not the type of name to double in a month, deep down we do think shares can put on a good show if the market gets moving, with the rapid/reliable growth story attracting more big buyers. If you’ve followed along with us, continue to sit tight. HOLD

Devon Energy (DVN)—When we originally bought DVN back in May of last year, energy stocks were doing pretty well, but sentiment-wise, the group was definitely not loved and still thought of as boom-bust, with the prospects of the explorers very much determined by the price of oil. Ten months later, the sector is super hot, the cash flow/CapEx controls/low production growth stories are much more widely known and accepted (at least among the institutional crowd) and, when it comes to the price of oil itself, the news could hardly be better, with the Russian invasion and corresponding sanctions throwing the energy market into chaos. Said another way, at this point, a lot of good news and expectations have likely been priced into DVN and the group as a whole, which raises near-term risk, and when you combine that with the fact that DVN had grown to a massive portion of our overall portfolio (just shy of 20%, nearly double that of a “normal” initial position), we thought it was best to feed a few of the ducks (buyers) while they were quacking—thus, on Tuesday’s special bulletin, we sold half our shares. A couple of other points: When it comes to the dividend, we won’t get the $1 payout on the half we sold, though we don’t see that as some huge chunk of change given that DVN itself moves around a dollar every few hours these days. (The dividend itself was always nice, but what counted more was what that payout did for investor perception—namely, increasing it, and thus driving the stock much higher.) Second, big picture, we think DVN can head higher over time, so we’re willing to give our (still-sizable) remaining stake room to maneuver. We’ll have to see if Devon and others do renege on their promise to keep CapEx in check in order to boost production (that could be a short-term negative), but we certainly don’t think the major cash flow story is set to change in any meaningful way, and the group was out of favor for so long (2014-2020) that the odds favor the next correction will find support. Long story short, we held through many dips and survived many tests during the past 10 months, and now that oil and gas is the talk of the town, we think it makes sense to book partial profits, while sitting tight with the rest of our position and seeing how things play out. SOLD HALF, HOLDING THE REST

ProShares Ultra S&P 500 Fund (SSO)—The S&P 500 fell as low as 4,220 or so in late January, and has since tested that low the day of the Russian invasion (it actually fell as low as 4,110-ish) and again on Tuesday of this week (4,160). But so far, those dips have found support, and as we talked about on page 1, the number of new lows continues to dry up (we showed the Nasdaq, but the new lows on the NYSE also dried up nicely on this week’s retest), telling us fewer stocks are participating on each dip. That doesn’t mean for certain that we’re out of the woods (we need to see some sustained up action to go there), but given that we’ve held SSO through the correction so far, that we have a huge amount of cash and that the fund is still a small-ish portion of the overall portfolio, we continue to think holding is the best option. Ideally, the past few weeks have been a bottom-building process and SSO will head up from here—and if not, we’ll likely sell the rest of our stake should the recent lows break. Hold for now, and let’s see if the nascent rally can gain some steam in the days ahead. HOLD

Watch List

• CarGurus (CARG 42): CARG has a nice core business, but the main attraction here and new growth engine is CarOffers, which is becoming a go-to platform for dealerships. See more later in this issue.
• Dutch Brothers (BROS 53): BROS isn’t in an uptrend yet, but it’s repeatedly found support in the 40 to 43 area, has etched slightly higher lows since January and has a cookie-cutter story that’s easy to love. The volatility here is extreme (20% moves over a couple of weeks aren’t uncommon), but if it kicks into gear from here we’ll likely take a swing at it, possibly even before an official market timing buy signal.
• Halliburton (HAL 38): As we write later in this issue, commodity stocks are near-term suspect, but we continue to think early-stage ones like HAL can do well for many quarters to come—a couple of weeks of rest or chopping around as the 50-day line (now just above 30) catches up could be interesting.
• Inspire Medical (INSP 224): INSP is a small medical device name; we think the group could help lead the next advance. The stock hasn’t made any net progress for a long time (13 months), but has very strong growth (sales up 70% in Q4) and a life-changing product for many (better mousetrap for sleep apnea).
• Intra-Cellular Tech (ITCI 57): ITCI is small and somewhat speculative, but it acts great thanks to a gamechanging treatment for Bipolar disorder. See more below.
• Palo Alto Networks (PANW 553): PANW is one of the better-looking growth stocks, though it’s a lone ranger in its group (other cybersecurity stocks are still iffy at best) and, frankly, we actually like the fundamentals of some of its peers better. Still, the numbers, overall story and chart look good, with shares looking ready to get going if the market does.
• StarBulk Carriers (SBLK 30): After many years in the doghouse (shares fell from 70 to 4 from 2014-2020), SBLK is now thriving, with tight supply and elevated day rates leading to enormous earnings and dividends. To be fair, shippers are as cyclical as they come, but with industry-wide new orders still near multi-decade lows, our guess is SBLK can thrive for much longer than expected.

Other Stocks of Interest

CarGurus (CARG 42)—CarGurus has always had a nice business—the firm was founded years ago essentially as a way for individual dealerships (many of which lack the ability or know-how to market themselves outside of goofy local commercials) to connect with more potential buyers—as opposed to competing with dealerships (like, say, a Carvana). CarGurus lets consumers search for inventory at dealers near them; it’s basically the Zillow model but applied to dealerships instead of real estate agents. CarGurus is the biggest of the pack, and it’s nearly three times as likely to be the final auto shopping site visited before a car purchase, compared to competitors. It’s been a solid, steady growth story for years, signing up nearly 30,000 dealers at its peak; that figure has fallen recently as the pandemic hurt things, though revenue per dealership continues to grow. The core business should recover going forward, but it’s not the growth driver anymore—instead, the story is now about CarOffers, which it acquired at the very start of 2021. Instead of focusing on the consumer side of things, CarOffers effectively replaces the auction market for vehicles between dealers, with a flat-fee (no subscription) offering that is nationwide, allows for group trades, saves vast time for buying and selling dealerships and even allows for dynamic bidding. (It’s become especially important now as inventories are still crimped in the auto sector.) In the middle of last year, 5,500 dealer locations were enrolled with CarOffers, but by mid-February, that figure had doubled, and gross merchandise sales on the platform are growing even faster! Plus, CarOffers has moved into the “instant cash offer” business, allowing its dealership clients to bid on used cars that consumers want to sell—giving the small fry in the industry the same abilities as a Carvana or Carmax. In Q4, CarOffers itself made up just over half of CarGuru’s total revenue, lifting a whopping 184% from the prior quarter, and the subsidiary was cash flow positive, too. For CarGurus as a whole, analysts see relatively flat earnings this year (likely conservative even as expansion efforts ramp) but see the top line lifting 87%, with another 30%-plus gain likely in 2023. After years of lackluster performance, CARG exploded higher after the Q4 report, though it’s since given back a good-sized chunk of that, which is par for the course in this environment. Still, the company (thanks to CarOffers) has the story and growth potential to be a fresh leader when the market finds its footing.

Doximity (DOCS 50)—The first wave of cloud software stocks to do well years ago were very general, with their hands in many cookie jars (think Salesforce.com). Then came leaders that served a specific function that applied to many sectors; Coupa’s purchasing solutions is an example. Going forward, while all cloud names have been cut off at the knees, we think the next wave could be those that dominate a large industry niche in need of modernization. Enter Doximity, whose cloud platform for physicians is the hands-down leader (80% of physicians and half of nurse practitioners use it), and for good reason, as it makes doctors’ lives much easier, allowing them to put aside snail mail and regular faxes (still prevalent in doctor’s offices), instead performing various tasks right from the firm’s app on their smartphone: Signing, sending and receiving e-faxes; secure messaging with verified physicians on the network for referrals (they can refer a patient with the click of a button), collaboration and more; calling a patient from their personal phone but using the practice’s phone number for ID; easy telehealth meetings (again, right from a doctors phone) with patients, who don’t have to download an app (99% of hospital clients renewed their telehealth agreements with Domixity last year); personalized news feeds of only relevant medical studies and information; salary ranges so physicians know what they should be worth (job listings grew four-fold in Q4 from a year ago!); and, via a recent acquisition, Doximity allows clients to manage their scheduling, too. Because of network effects, hospitals and prescription outfits are also big customers (top 20 pharmaceutical companies are all signed up) and use Doximity’s marketing tools to get their products, clinical trials and more in front of more doctors’ eyes; third-party studies show some ridiculously large returns on that spending. Basically, the company has come up with a far better digital mousetrap for physician’s and is set to get a lot bigger as customers use many more of its services—in Q4, revenues rose 67%, led by the biggest customers (six-figure customers lifted 50%; the top 5 grew their spending by 90%!), while EBITDA was up 119%. As with most firms, Doximity is projecting growth to slow (analysts see the top line lifting 33% in the coming year), but that’s almost surely conservative as the firm’s platform becomes the online/app hub of the physician world. As for the stock, we can’t say DOCS is strong—it’s been caught up with the crash in growth and cloud stocks just like everything else. However, such a post-IPO slide isn’t unusual even in normal environments, and the stock did pop on earnings early last month and is trading above its prior low. It has work to do, but the longer DOCS can hold up, the greater the chance it’s begun its bottom-building phase.

Intra-Cellular Therapies (ITCI 57)—If you’re looking at a money-losing firm with less than $100 million in revenue, a single product and a market cap near $5 billion, you’d guess that the stock is at least 50% (if not 60% or 70%) off its high in this market. But here’s Intra-Cellular Therapies, hanging 7% off its high and looking like it wants to head nicely higher once the market bottoms out. The story here surrounds Bipolar depression, which unfortunately is a huge and growing market; 11 million people in the U.S. alone have the disease, which comes with double the risk of all-cause mortality not to mention severe impairment in day-to-day life. Despite this, there’s not much in the way of approved treatments, but Intra-Cellular has hit on something that looks big: The firm’s Caplyta treatment (a once-daily pill) is approved for adults with schizophrenia, Bipolar I or II, and as a single therapy or (unlike most other treatments) in concert with other measures, with trials showing 17% to 30%-plus additional decrease in depression measures compared to placebo. There are additional indications in late-stage trials as well (two Phase III studies are underway looking at Caplyta as an add-on therapy for major depressive disorder, which affects another 21 million people), but the near term is about how fast Intra-Cellular can penetrate the market. Thanks to a beefed-up specialty sales force that’s targeting more than 40,000 physicians, it’s off to a good start, with prescription growth accelerating after last December’s Bipolar approvals (it had been approved for schizophrenia in 2020), bringing in around $25 million of revenue in Q4. But that’s just the tip of the iceberg, with analysts seeing the top line leaping north of $210 million this year and up to $435 million in 2023—and any positive label-expanding trial results could also help the cause. Shares are herky-jerky, but some smart funds have taken positions, and since a market- and share offering-related dip in January, the stock has been pushing higher since, only pulling back a few points in recent days as the market has sagged. Sure, it’s small and there’s obviously risk something goes awry, but ITCI’s resilience is notable, and it looks like it has a blockbuster treatment on its hands.

What to Make of Commodity Stocks Now?
In mid-2021, the common thought was that elevated commodity prices—born from a loose monetary policy, a recovering, post-pandemic economy and ongoing supply chain issues—would fade as the year went on. Indeed, many commodity stocks peaked in the spring of last year and bobbed and weaved for months despite posting huge results. But as perception changed that these elevated prices may stick around, the stocks embarked on another run late last year and in early 2022, resisting the market’s January decline.

And of course, in recent weeks, everything has gone haywire, with the Russian invasion and related sanctions sending a variety of commodity markets into chaos—and in turn leading many stocks to go vertical. The question is what to make of them now, and whether they have any gas left in the tank (ahem) in the weeks and months to come.

We’re going to answer those as two separate questions because we have two different thoughts depending on the time frame.

Near-term, we’re picking up on more than a few clues that many stocks may be getting ready to shake out, not the least of which is clear to many: The surges in commodity prices (oil and gas are the most obvious, but even things like wheat and aluminum have made lots of headlines) have become very obvious to the crowd, as have the moves in the underlying stocks. Indeed, commodity-related names are just about the only area of the entire market that looks good!

Throw in the fact that these stocks are very extended to the upside and that we’re seeing some leaders stall out a bit despite the massive rally in the underlying commodities, and we think risk is elevated that some type of pothole materializes. Obviously they could go higher first, but some sort of 10% to 25% dip in a few days wouldn’t be surprising at all. That’s one reason we took partial profits in Devon Energy (DVN) this week; it’s had a huge run for over a year and the last breakout was back in September. If you happen to own a high-flying commodity stock or two, we think taking a few chips off the table makes sense.

All that said, we still think there could be opportunities in the group after the next pullback—though we think it will be more selective than the recent melt-up. As usual, we’re looking for stocks that should (all else equal) be somewhat early in their advance and leaders in their field.

In fact, most of the overall metals and mining sector looks to be in that same boat: Check out S&P Metals and Mining Fund (XME), which got going from an eight-month rest in February and has gone vertical of late. There are no sure things, but odds favor a sharp pullback and/or a couple of weeks of rest could set up an entry as some moving averages catch up.

As for individual stocks, one idea is Chesapeake Energy (CHK), which is mostly about natural gas instead of oil, so it spent October-January consolidating. More important, CHK came out of Chapter 11 in early 2021, so nobody can say the stock is over-owned at this point. And the cash flow profile here rivals any oil name—having already slashed debt (0.7x annual cash flow), the company sees around $2 billion of free cash flow this year at current strip prices, which is likely about 15% of the market cap (adjusted for a pending acquisition), about half of which will be paid in dividends while $500 million (~4% of the market cap) will be used for buybacks—while the next few years should look similar. The stock staged a beautiful breakout in late February and went straight up; the current dip could easily go further or last longer, but we think the next major move will be up.

There are other names—including StarBulk (SBLK), which we wrote about in late January and continues to act well; it’s on our watch list—that we could look at going forward, but suffice it to say that, near-term, we could see a cooling off period in this sector, but the odds still favor many commodity-related stocks moving higher down the road.

And as for Growth …

We had a good question from a subscriber this week, who asked: If the market does get going, what growth areas are set to lead? And our answer was … we’re really not sure yet. Frankly, while some things have stopped going down, most growth titles (along with most stocks in general) are still mired well below longer-term moving averages. Said another way, there’s not a lot of traditional buy setups (breakouts to new highs or early-stage pullbacks) out there right now.

Thus, if (obviously still a big if) we do get a green light in the near future, besides taking a stab at a commodity name on dips, we may shoehorn our way into a couple of half-sized positions in growth stocks that are showing some relative strength, even if they’re still well off their prior highs—possibly something like Dutch Bros. (BROS), which isn’t in an uptrend but has (so far) found solid support north of 40. Cookie-cutter restaurant peer Sweetgreen (SG) is another example, or maybe something like Inspire Medical (INSP), which is simply in the middle of a big base-building effort.

Those names are just examples; maybe we don’t jump into any of them. But our point is that you have to adjust to what the market is offering and cast a wider net given the recent environment. If the buyers return, don’t be surprised to see us nibble on a couple non-traditional charts.

Cabot Market Timing Indicators

The story remains mostly the same: When looking at certain (though not all) secondary measures, there are reasons for encouragement, with a decent bottom-building process underway now for six weeks. But until we see some improvement in the tried and true evidence—trends of the market and leading stocks—it’s best to remain in a defensive stance.

Cabot Trend Lines: Bearish
Our Cabot Trend Lines remain on the outs, with both the S&P 500 (by more than 5%) and Nasdaq (by nearly 11%) holding clearly below their respective 35-week moving averages. Of course, the Trend Lines are a background indicator and won’t precisely pick a low, just like they didn’t mark a top. But the longer-term trend being negative remains a hurdle for the bulls even if the market can start to bounce.

Cabot Tides: Bearish
Our Cabot Tides also remain negative, though the action bears watching—despite the horrid worldwide events, the major indexes have basically been hacking around in a wide range since late January, and thus, a few days of strong action could actually turn the intermediate-term trend up. However, as with all trend measures, we have to see it to believe it; right now, the trend is down, and until that changes there’s no good reason to put too much money to work.

Cabot Real Money Index: Neutral
There’s no doubt that the news environment is bad and sentiment has worsened, but we haven’t seen much movement when it comes to people’s actual money. Our Real Money Index remains in neutral territory, with net inflows hitting equity funds and ETFs of late despite the rough market.

Charts courtesy of StockCharts.com

The next Cabot Growth Investor issue will be published on March 24, 2022.